102-09 How to build a good stock trading system

10 Building Blocks to a Professional Stock Market System

After you have undergone stock market education in fundamental and technical analysis, you will be ready to start to create your stock market trading system.

Developing a stock trading system combines logic, knowledge, experience, art, and science. Your system will need to perform well (higher than 6.5% on average per year) historically and be expected to perform well in the future, at least for the time frame in which you expect to use it. The “Nirvana” of a trading system would need to perform well and need little “user interpretation” for it to function. This would mean using “trading robots” or a mechanical method. It is not necessarily a good idea to use a trading robot as that would place your trades for you as this will essentially take any on-the-fly decision-making out of your hands. However, you should use a mechanical method (computer) to help you test your systems and create the buy and sell signals for you.

In this context, your systems would have the following requirements.

  • A good stock trading system will need to be backtested to prove that it worked in the past. This would give you an element of proof that the logic upon which we based our assumptions are working.
  • A good system allows us to trade with less emotion providing a market advantage. Emotion is known to be the culprit of many trading errors and losses.
  • Automation of the fundamental screening for the stocks will save us time.
  • Automation of the Technical Indicators Scan will also narrow the list further to focus only on our preferred candidates.

Step 1 – Get educated.

The first step is to read books and continually learn. For a list of excellent stock trading books, try this link.

The Top 24 Best Stock Market Investing Books of All Time

Step 2 – Choose your favorite time frame for trading or investing.

If you have the time to immerse yourself in the stock market fully, you might want to trade shorter time-frames (days to weeks). If you have a full-time job and less free time available, you may want to trade longer time-frames and only monitor your stocks every week.

Step 3 – Choose your favorite markets.

As an active trader, you should choose your stock markets wisely. If you want to be active, checking your stocks intra-day or daily, it may be wise to trade a stock market that is not in your time zone. For example, Mr. Smith has a busy day job and only has time free in the evening. Mr. Smith is based in India. Normally he would want to trade the Indian stock markets. But actually, the European markets might be a good choice as they open close to the end of his working day. Therefore, he can focus his spare time on the stock market in question.

If you are a less active trader, then it might be wise to trade the stock market in your time zone as you may have the advantage of being able to spot successful companies in your country and investigate them further using your local knowledge.

Step 4 – Understand what your profit target is

What is your target? Active traders should expect higher returns/profits as they spend more time trading the market. Less active traders might expect a slightly lower return as the trade-off for not being as focused. But what is a good target? Do not believe the scam artists of “Penny Stocks Newsletters” and peddlers of “microcap stocks”; in the real world, 100% or 1000% profits are not realistic; in fact, it is irresponsible that they would promote their services in this way.

Warren Buffet has averaged just over 24% annual return over his entire career. That is just 2% per month. Realistically you should choose this as a viable upper target.

Step 5 – Select your favorite fundamental screens.

You need to understand the meaning of Capitalization, Earnings per Share, Earnings Acceleration, five-year revenue % increase, Price Earnings Ratio. You will learn these topics later in this course.

Step 6 – Select your preferred stock market indicators using technical analysis.

What Chart should you use?

  • Bars
  • Candlesticks
  • Point and Figure Charting
  • Ichimoku Cloud Charts
  • Market Profile

How to Read Stock Charts For Beginners + eBook/pdf

What indicators should you use?

  • Price Indicators – the study of price-based chart indicators or oscillators are known as Stochastics, Relative Strength (RSI), Rate of Change (ROC), Moving Averages (MA), Moving Average Convergence Divergence (MACD), Parabolic SAR, and Average Direction Movement Index (ADX).
  • Study of Volume – understanding how the volume level has a relationship with the price – and how the price has a relationship with volume.
  • Study of Price Volume Indicators – On Balance Volume (OBV), Chaikin Money Flow, Time Segmented Volume (TSV), MoneyStream.

Top 10 Tips For Using Stock Chart Indicators Effectively.

Step 7 – Turn your previous choices into specific rules.

Quantify your choices of the fundamental screens and technical analysis screens.

At what point would you buy?

  • When does the ten-day Moving Average cross the 20-day moving Average and holds above price for two days?
  • When RSI holds above the RSI 5 days Moving Average for two days?

At what point do you sell?

  • When MACD turns negative?
  • When you see a negative divergence in Money Flow?

Step 8 – Run your rules and backtest

Using backtesting software, you can implement your rules and see if they actually work historically. This is a fascinating and immersing topic.

If the system produces the targets you expect, move to step 9.

7 Best Stock Backtesting Software For Trading Strategies 2022

Step 9 – Let your rules run.

Let your rules run for a month or two to see if it continues to perform.

Step 10 – Go or No Go

If successful – Implement the system – If unsuccessful – tweak the system and start again from step 5.

If your rules are working, implement your system start to trade it. If not, you may need to refine the system. The best systems have been refined repeatedly to remove logical errors and improve the percentage of winning trades and the percentage of profit per trade.

The results of a great stock trading system

Building and running a trading system takes time, a logical mind, and patience. Many successful traders have started to make losses because, through boredom, they have deviated from their winning system or strategy. Try not to make the same mistake.



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